Download Chapter 13

Chapter 13
Buying Life
Insurance
Copyright © 2011 Pearson Prentice Hall. All rights reserved.
Agenda
•
•
•
•
Determining the Cost of Life Insurance
Rate of Return on Saving Component
Taxation of Life Insurance
Shopping for Life Insurance
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13-2
Determining the Cost of Life Insurance
•
•
The cost of a life insurance policy is the
difference between what you pay and what
you get back
When determining the cost of life
insurance, four major factors must be
considered:
1.
2.
3.
4.
Annual premiums
Cash values
Dividends
Time value of money
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13-3
Determining the Cost of Life Insurance
• Under the traditional net cost method, the
cash value and expected dividends are
subtracted from annual premiums to
obtain a net cost per year figure
– This method does not consider the time value
of money
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13-4
Exhibit 13.1 Traditional Net Cost Method
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13-5
Determining the Cost of Life Insurance
• The interest-adjusted cost method is more
accurate because it considers the time value
of money
• Interest-adjusted cost indices come in two
forms:
– The surrender cost index is useful if the owner
expects to surrender the policy after some time
period
– The net payment cost index is useful if the owner
expects to keep the policy in force
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Exhibit 13.2 Surrender Cost Index
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Exhibit 13.3 Net Payment Cost Index
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Determining the Cost of Life Insurance
• Interest-adjusted cost indices can be used
to compare policies across insurers
– There is a wide variation in costs indices across
insurers – it pays to shop around!
– Most consumers use premiums as a basis for
comparison, but agents will supply cost indices
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13-9
Exhibit 13.4 Whole Life Actual Historical Performance $250,000
Male Nonsmoker Preferred Class, Age 45 Policy Issued
12/31/1988. Last Day 12/31/2008.
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13-10
Determining the Cost of Life Insurance
• The Life Insurance Policy Illustration Model Act
requires insurers to present certain information to
applicants for life insurance
– The goal is to reduce misunderstanding of policy values by
policyowners, and reduce deceptive sales practices by
agents
– A narrative summary describes the basic characteristics of
the policy
– A numeric summary shows the premium outlay, value of the
accumulation account, cash surrender values and death
benefit
– The act also prohibits certain sales practices and requires the
insurer to provide an annual report
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13-11
Rate of Return on Saving Component
• The annual rate of return earned on the
savings component of a policy is an
important consideration if you intend to
invest over a long period of time
• The Linton yield is the average annual rate
of return on a cash value policy if it is held
for a specified number of years
– Current information is not readily available to
consumers, so the method has limited use
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13-12
Exhibit 13.5 Average Annual Rates of Return
for 109 Cash-Value Policies by Year of Policy
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13-13
Rate of Return on Saving Component
• The yearly rate of return method is based on a
formula:
 amount available in the policy   assumed price of the

  
 at the end of the policy yea r   protection component
 amount available in the policy 


at
the
beginning
of
the
policy
yea
r




 1
• The information needed for the calculation is
readily available to consumers
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Exhibit 13.6 Benchmark Prices
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13-15
Taxation of Life Insurance
• Life insurance proceeds paid in a lump
sum to a designated beneficiary are
generally received income-tax free
– The interest component of periodic payments is
taxable as ordinary income
– Premiums are generally not deductible
– Dividends are not taxable, but interest on
dividends retained is taxable
– If a policy is surrendered for its cash value, any
gain is taxable as ordinary income
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13-16
Taxation of Life Insurance
• Proceeds from a life insurance policy are included
in the gross estate of the insured for federal
estate-tax purposes if:
– the insured has any ownership interest
– they are payable to the estate
• The proceeds may be removed from the gross
estate if the policyowner makes an absolute
assignment of the policy to someone else
– The policyowner must make the assignment more than
three years before death
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13-17
Taxation of Life Insurance
• A federal estate tax is payable if the decedent's
taxable estate exceeds certain limits
– A tentative tax on the taxable estate value is calculated
• The gross estate includes property you own, one-half of the
value of property owned jointly with your spouse, life insurance
death proceeds in which you have ownership interest
• The gross estate may be reduced by certain deductions, such
as a marital deduction, in determining the taxable estate
• The taxable estate may be reduced or eliminated by a tax
credit called a unified credit
– The amount of property exempt from taxation will increase
in the future
– Federal estate taxes are scheduled to expire in 2010
• Tax will be reinstated in 2011 unless Congress acts
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Exhibit 13.7 Calculating Federal Estate
Taxes*
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Exhibit 13.8 Shopping For Life Insurance
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Exhibit 13.9 Rating Categories for Major
Rating Agencies
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